Bernanke Nuclear Option

Intressanta tankar av Yelnick.

(En bloggare)

The bond market is very hard to read. This is because Bernanke has chosen to go nuclear and helicopter money directly into the economy by purchasing Treasuries. Normally he buys from the Treasury, creating money; then sells into the open market, removing money. This time he is buying in the open market, creating money, and not sterilizing it. He has previously weakened his balance sheet by accepting a bunch of questionable debt from banks, and maybe he wants to begin swapping that poor reserve debt out for Treasuries. But his stated goal is to keep interest rates low by paying above market for Treasuries. His goal is to lower the cost of financing the huge deficits, as well as try to restart the housing market with even lower rates.

The Fed has tried this once before, in Operation Twist from 1959 to 1966. Then the long rate was 2.5%, and had moved up to 3%, and the Fed wanted to get it down again. What happened instead is the Great Inflation of 1965-1981, and long rates rose to 6% before the Fed gave up. Put simply, the gimmick of Twist created the inflation, rather than lower borrowing costs. In a nutshell, a disaster.

The Brits began the same idea several weeks ago, and a couple of days ago were unable to sell out their version of Treasuries, called Gilts. The Brown government may fall over this.

The Fed auction yesterday was ominous. Very weak auction. Foreign buying was down 50%. You have to believe the minute the Fed made offers to buy above market, the Chinese among others tried to sell back. They must have had overwhelming bids.

If bond prices stay lowish, then the rally is in fine shape. If bonds peak and rates start to rise, revisit the decision to hold these stocks. My bet is that the rally goes several months, and the Bernanke Gambit works for a while, then begins to fail. And the market begins to fall. Hence watch the bond market as a leading indicator of stocks.